Financial Friction

Imagine coming home from work and telling your spouse that you lost $377 million dollars in a Ponzi Scheme. Now imagine that you are legendary investment guru Warren Buffett and admitting this to shareholders in his company, Berkshire Hathaway. #BadDayAtWork.

Mr. Buffett has more investment wins than losses. That's why he's known as the Sage of Omaha and Berkshire's annual shareholder meeting looks like a cult meeting. Buffett and his 95 year old Vice Chairman, Charlie Munger have decades of wisdom, experience and a vast team of corporate talent that provides research. This gives Berkshire a massive advantage in weeding out good opportunities from bad ones.

None of that mattered in this loss. He got swindled out of $377 million dollars!

Here's the scene when it all fell apart:

We need to learn from his loss to hopefully avoid some of our own. Let's look at his potential mistakes.

Mistake #1- The investment was in a new company with little financial history. As I write this, Uber just priced their initial public offering. Customers know the company and enjoy the transportation benefits. Uber has a limited financial history which consists of losing money not earning profits. This type of "investment" is for speculators only. Stick to investments that have been making money for a decade or more. This alone will dramatically reduce the potential for fraudulent outcomes.

Mistake #2- His solar investment thesis apparently focused on tax-related benefits more than investment activity returns. We invest our money to earn a return from the investment activity of the business. If the company's business turns a profit, you have a strong chance of earning a positive return. Real estate limited partnerships in the 70's and 80's relied on complicated tax benefits to entice wealthy investors into parting with their cash. With a simple IRS tax law change, these benefits were wiped away over night and so were most LP's. Nowadays, insurance products are often marketed as tax savvy "investments" but at the end of the day, it's an indemnity policy that should insure you against some sort of specific loss (life, income, health etc.) period.

Mistake #3 - He didn't recognize the problem soon enough. Berkshire made investment in DC Solar from 2015 all the way through 2018. At LeConte, we tend to be deep value investors which means we like to buy cheap investments. The trick is to differentiate when something is cheap (for a reason) and when it is worthless. After 3 years, Berkshire should have realized their solar play had issues.

Mistake #4 - Buffett was a victim of his own hubris. Over time investors can fall victim to attribute their success to skill rather than good fortune. The Good Book reminds us that Pride comes before a fall. Stay humble or markets will make you humble.

We are never too old (or too smart) to learn and improve. I suspect that Buffett will make adjustments after this loss. Don't feel sorry for him though. $377 million is a chunky loss but Berkshire has more than 100 Billion sitting in cash. Warren and Charlie will be fine.